Recently, the government has introduced a series of monetary policies and real estate relaxation policies. What might be the scale of the upcoming fiscal stimulus policies, what directions should they focus on, and when might they be introduced?

What might be the scale of fiscal stimulus policies?

Since September 24, 2024, the government has introduced a series of macroeconomic easing and real estate support policies (please refer to our previous comments and interpretations of the Politburo meeting). The market is currently expecting the government to introduce large-scale fiscal stimulus measures, with some market participants believing the scale could exceed 10 trillion yuan. In this report, we summarize the main directions that potential large-scale fiscal stimulus policies should support. However, we believe a more reasonable expectation is that the government will introduce a more moderate fiscal stimulus policy of 1.5-2 trillion yuan in the short term; at the same time, based on our previous baseline forecast, fiscal policy support in 2025 may expand by an additional 2-3 trillion yuan. Important policy timing may include: fiscal stimulus policies for this year may be introduced after the Golden Week holiday or around the release of third-quarter data on October 18, while fiscal stimulus policies for 2025 may be discussed and decided at the Central Economic Work Conference to be held in December 2024.

Policies already announced. Since September 24, 2024, the government has introduced a series of policies to support the real economy and financial markets. Monetary policy easing includes a comprehensive interest rate cut of 20-30 basis points, a reserve requirement ratio cut of 50 basis points, and the central bank has indicated that further reserve requirement ratio cuts are possible in the future (please refer to our previous comments). In terms of real estate policies, the government has reduced the minimum down payment ratio for second homes nationwide from 25% to 15%, reduced the interest rates for new and existing loans, significantly relaxed purchase restrictions in first-tier cities; most importantly, the Politburo meeting first proposed to promote the stabilization and recovery of the real estate market (see interpretation of the Politburo meeting). In addition, the central bank has also created new monetary policy tools to support the stable development of the stock market, including stock buybacks and increased loans for repurchase, supporting non-bank financial institutions to swap with the central bank to obtain liquidity, and encouraging corporate mergers and acquisitions. Other policies include various measures to support the private sector and enterprises, as well as plans to increase core tier-one capital for large state-owned commercial banks. The government has not yet announced large-scale fiscal stimulus measures or made significant adjustments to the real estate deinventory mechanism, but we believe the Politburo meeting has released a clear willingness to further support policies, which has also raised market expectations for these two policies.

The market's expectations for the scale of potential fiscal stimulus range widely, from 2 trillion to over 10 trillion yuan (or 1.6-8% of GDP). Most investors are already aware of the September 26, 2024, Reuters report, which mentioned that the government might issue an additional 2 trillion yuan in government bonds to stimulate consumption and alleviate fiscal pressure on local governments. In addition, Bloomberg reported that the government might issue 1 trillion yuan in special government bonds to increase core tier-one capital for large state-owned commercial banks. In addition, some market participants are discussing the possibility of the government introducing a larger-scale fiscal stimulus, possibly reaching 10 trillion yuan or more (accounting for 8% of GDP), but it is currently unclear how much of this scale is new stimulus and what the policy coverage time dimension is. If a larger-scale fiscal stimulus is introduced, most people expect that the vast majority will be used to address the financing gaps and debt issues of local governments (including arrears to enterprises), and significantly increase financial support for real estate deinventory. In addition, investors generally believe that the policy will include capital injections into large state-owned commercial banks, support for the residential sector through increased social welfare spending and subsidies to residents, and tax cuts and fee reductions for enterprises.

What fiscal support policy assumptions are included in our current baseline forecast? When we lowered our GDP growth forecasts for 2024 and 2025 to 4.6% and 4.0% respectively in late August (please refer to the report on lowering GDP growth forecasts and lowering real estate market forecasts), we had already assumed that policy support would further intensify to boost economic growth within the year. We estimate that the broad fiscal contraction in the first half of 2024 was 0.4% (as a percentage of GDP), far lower than the full-year broad fiscal expansion of 0.8-1% planned in the fiscal budget case at the two sessions in March (for comparison, the broad fiscal contraction in 2023 was 0.5% of GDP). We expect the government to accelerate the issuance, funding, and use of government bonds, and provide financial support for the debt restructuring of local financing platforms, thereby partially offsetting the drag of weak fiscal revenue and expenditure in the first few months of this year. This means that we have already assumed that the broad fiscal needs to expand by 1-1.2 trillion yuan in the second half of 2024, thereby promoting the annual broad fiscal deficit to rise by 0.3-0.4% compared to 2023 (as a percentage of GDP). In addition, our current baseline assumption is that the broad fiscal deficit will expand by about 1% in 2025 (as a percentage of GDP), including the issuance of 1.5 trillion yuan in special government bonds and 4 trillion yuan in local government special bonds (1 trillion yuan and 3.9 trillion yuan respectively in 2024), and slightly expanding the general fiscal budget deficit ratio to 3-3.5%.

How much fiscal stimulus does China need? It depends on the government's planned goals. If the goal is to have the GDP growth rate close to the annual economic growth target of "around 5%" in 2024, then it may only need to implement a fiscal stimulus of 1.5-2 trillion yuan as soon as possible. If the goal is to stabilize real estate market activity in the next few months, or completely offset the downward drag of the real estate market on the economy, and reverse the spiraling decline in price levels, business and consumer confidence, thereby achieving close to 5% GDP growth in the next two years, we believe the government needs to introduce a larger-scale policy stimulus, and vigorously promote structural reforms. In addition, if the United States significantly increases import tariffs on Chinese products, the government will also need to introduce a larger-scale fiscal stimulus.

Where does fiscal policy need to focus and what might be the scale?

1. There is at least a 1.3 trillion yuan gap in fiscal revenue, which can be filled by issuing special government bonds or general government bonds. In the first eight months of 2024, we estimate that the general public fiscal revenue gap (relative to the budget plan) is 900 billion yuan (an annualized scale of 1.3 trillion yuan), while fiscal expenditure is 430 billion yuan lower than the budget (an annualized scale of 690 billion yuan). Local government land transfer income decreased by 25% year-on-year, which is 690 billion yuan lower than the fiscal budget case's expectation of roughly flat (although our baseline forecast has already assumed a 10% decline), and the reduction in government fund budget expenditure (mainly financed by local government land transfer income and the issuance of local government special bonds) is even greater. Therefore, to achieve the 2024 general public fiscal budget plan (while temporarily ignoring the significant decline in government fund budget revenue and expenditure), the government needs to fill a financing gap of 1.3 trillion yuan.2. Debt restructuring and repayment for local financing platforms may require over 1 trillion yuan and over 2 trillion yuan respectively. The UBS banking team estimates that as of the first half of 2024, the stock of interest-bearing debt for local financing platforms is about 65 trillion yuan. Thanks to debt restructuring with banks and the issuance of 1.4 trillion yuan in special refinancing bonds by local governments in 2023 to replace some local financing platform debt, the debt repayment pressure on local financing platforms has eased over the past year and a half. We believe that in the coming months, the government will need to issue over 1 trillion yuan in additional special refinancing bonds for local governments, which can continue to utilize the gap between the local government debt limit and balance at the end of 2023 (1.43 trillion yuan), and issue an additional 1-2 trillion yuan in 2025. A more pressing issue may be that we estimate local financing platforms have trillions of yuan in non-interest-bearing liabilities in the form of accounts payable, and due to the shortage of local government funds, this liability scale may be increasing significantly. We estimate that local financing platforms currently need at least 2 trillion yuan in funds to reduce their accounts payable to a "normal" level and reduce arrears to the corporate sector.

3. Provide residents with income and consumption subsidies of over 500 billion yuan. We believe this could include income subsidies of 100-200 billion yuan for those in extreme difficulty and the long-term unemployed; birth subsidies of over 200 billion yuan per year for families with two or more children (which could cover from newborns to preschool age); and expand the current subsidies for consumer goods trade-ins from 150 billion yuan per year to 300 billion yuan over the next 2-3 years. We also believe the government could increase tax deductions and/or raise the taxable income threshold for personal income tax for eligible residents, which could also bring over 100 billion yuan in support to the residential sector.

4. Increase social welfare spending by over 800 billion yuan per year. We believe that increasing social welfare spending, especially support for migrant workers, will help improve the social security system, promote social equity, and boost consumer confidence in the medium to long term. We estimate that if the basic pension payment standards for urban and rural residents are doubled (currently only 5% of the basic pension for urban workers), about 170 million residents will benefit in the short term, and in the long term, this will help boost the confidence of about half of the national population, requiring an additional 400 billion yuan in government spending per year. In addition, we believe the government could also spend an additional 200 billion yuan to increase the contribution standards for the basic pension for urban and rural residents. A third possible direction for government support is to exempt the lowest 25% of income earners from personal contributions to basic medical insurance, which we estimate would require an additional government expenditure of 200-300 billion yuan per year.

5. 3 trillion yuan in real estate inventory reduction financial support. We estimate that China may need 3 trillion yuan in funds for real estate inventory reduction in 80 major cities (static estimation, please refer to the real estate inventory reduction report). This could be supported by 3-4 trillion yuan in government special funds, which means the government would issue 1.5-2 trillion yuan in special national bonds or local government special bonds each year for two years, or it could be supported by the central bank's special re-lending tool to provide 3-4 trillion yuan in funds with lower interest rates (to 1% or lower, currently at 1.75%) and longer terms (5-10 years or longer, currently 1-5 years) to promote the inventory reduction process.

6. Provide financial support to enterprises of 500 billion to 1 trillion yuan (including tax cuts and fee reductions). In recent years, the government has been using tax cuts and fee reductions for enterprises as the main channel for fiscal support to the economy, especially during the COVID-19 pandemic. In 2023, the government estimates that the scale of tax cuts and fee reductions will total about 2.2 trillion yuan (including the extension of tax cuts and fee reduction policies during the pandemic). In our base forecast for 2024 and 2025, we assume that the scale of tax cuts and fee reductions for enterprises will be 1 trillion yuan. We believe that the scale of further tax cuts and fee reductions may be limited, not exceeding 1 trillion yuan per year.

7. Inject at least 1 trillion yuan into large state-owned commercial banks. On September 24, 2024, the government announced plans to inject core tier-one capital into six large state-owned commercial banks, which may require financing through the issuance of government bonds or Central Huijin bonds. The UBS banking team expects that the core capital ratio will increase by 1-2 percentage points, and Postal Savings Bank/Bank of Communications/Agricultural Bank may accept larger injections earlier, mainly due to their lower core tier-one capital ratios. UBS estimates that a 1 percentage point increase in the core tier-one capital ratio for Postal Savings Bank/Bank of Communications/Agricultural Bank would require injections of 86/90/221 billion yuan. Overall, we believe that this process may require at least 1 trillion yuan in funds over the next year or so.

What are the reasonable expectations for the scale and timing of fiscal stimulus?

Fiscal stimulus policies should target which directions for effort? As mentioned earlier, in 2024 and 2025, the government may indeed need to introduce large-scale fiscal stimulus policies to alleviate the revenue gap and financing pressure of local governments, effectively promote the real estate inventory reduction process, and provide support for residents, enterprises, and the banking industry. However, fiscal departments are usually more cautious, and fiscal resources are limited, with the main source of funds likely coming from additional issuance of government bonds. At this stage, we believe that the central government may not be willing to directly take on a large-scale local financing platform debt or directly provide fiscal financial support for real estate inventory reduction. The government may continue to promote the debt restructuring of local financing platforms and the real estate inventory reduction process through banks or the central bank (through re-lending tools, etc.). We believe that the central government may be more willing to provide one-time funds for the local government budget revenue gap, provide incremental bond financing for long-term projects, increase social welfare spending, and provide subsidies for residents.

How large is the reasonable expectation for fiscal stimulus? Therefore, we believe that a more reasonable expectation in the short term is for the government to introduce 1.5-2 trillion yuan in fiscal stimulus, including support for residents and enterprises, as well as filling the local government revenue and financing gap (and paying arrears to enterprises). For 2025, based on our current base forecast assumptions (1.5 trillion yuan in special national bonds, 4 trillion yuan in local government special bonds, and a general public fiscal budget deficit rate of 3-3.5%), fiscal policy may also expand by an additional 2-3 trillion yuan to support areas such as increasing fiscal spending and support for the residential sector, local financing platform debt restructuring, and fiscal support for key structural areas. Of course, if the United States significantly increases tariffs on Chinese products in the second half of 2025, the scale of fiscal support may be larger, or it may expand to support real estate inventory reduction and provide funds for exporters. The above expectations for fiscal expansion in 2024-25 do not include the government's announced plan to inject capital into state-owned banks (we estimate at least 1 trillion yuan).

When might fiscal stimulus policies be introduced? So far in 2024, the government has not introduced strong fiscal stimulus policies, which surprises us; we expect new fiscal stimulus policies to be announced in the next few days/weeks. We believe the most ideal situation would be to introduce fiscal stimulus policies immediately after the Golden Week holiday, which aligns with market expectations; however, we also believe it may be introduced around the release of third-quarter economic data on October 18. We estimate that the September and third-quarter economic data will show continued weak growth momentum, but high-frequency real estate sales and Golden Week holiday consumption data in early October may improve, especially the former. For 2025, we expect that the annual Central Economic Work Conference held in mid-to-late December 2024 will discuss in detail the policy support and economic growth targets for next year. By then, the results of the U.S. election will have been announced, which also gives the government more time to assess external risks. If decision-makers announce specific measures for strong fiscal stimulus policies and the promotion of major structural reforms over the next 2-3 years in the coming months, we believe this may exceed market expectations.How significant are the upside risks to economic growth forecasts?

As we mentioned earlier, our current baseline forecasts for GDP growth in 2024 and 2025 are 4.6% and 4.0%, respectively, which already assume that the government will increase policy support (including a further reduction of policy interest rates by 30 basis points in 2025) and introduce moderate fiscal stimulus measures. So far, the policy support measures announced by the government have largely aligned with our expectations, although the government has also indicated that it will continue to ramp up policy support. If the government quickly introduces a fiscal stimulus package of 1.5-2 trillion yuan and implements most of the measures quickly, this year's GDP growth could reach 4.8%. Following that, if the government introduces a large-scale incremental fiscal stimulus in 2025 that leads to an earlier stabilization of real estate activity than we currently expect, and if the United States does not significantly increase tariffs on China or experience a recession, China's GDP growth could reach 4.5% in 2025. If policymakers introduce a comprehensive set of long-term large-scale fiscal policies (including the measures discussed above) and specific measures to advance structural reforms in the coming months, this could exceed market expectations.

In our latest baseline forecast, we expect the exchange rate of the Chinese yuan against the US dollar to be around 7 by the end of 2024 and 2025. Although the aforementioned upside risk scenario implies a more accommodative monetary and fiscal policy, we anticipate that the improved economic growth prospects will bolster market confidence in the Chinese yuan. If all other assumptions remain unchanged, the exchange rate of the Chinese yuan against the US dollar could rise to 6.9 and 6.8 by the end of 2024 and 2025, respectively.